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An asset class is a broad group of financial assets which have similar characteristics. There are four main types of asset class – cash, shares, property and fixed interest securities (sometimes called ‘bonds’). These main asset classes can be broken down into lower level asset classes. For example, shares can be broken down into UK shares, US shares and so on.
Below we show how the main asset classes can be broken down:
Asset allocation is the process of deciding which type of asset(s) or asset classes you want to hold in your portfolio and the balance in which you want to hold them. It’s an important part of designing a portfolio that matches your risk profile and investment goals. When you are looking at building your portfolio, it is a good idea to have a mix of assets within different asset classes. This helps spread investment risk as asset classes often behave differently depending on economic conditions. For example, while the value of one asset class may be falling, another may be rising to compensate which will reduce the overall impact on the value of your portfolio.
There is no right or wrong answer on the assets you choose and it is dependent on how much risk you are comfortable in taking. Investing in an asset class like shares will have higher risk than putting your money in cash, though there is the potential for greater return. Below, we show the correlation between the risk and potential returns.
A popular way of building a portfolio is to use funds (rather than individual shares). Using funds reduces risk by having exposure to a range of different assets which would be expensive to buy yourself. Funds can offer exposure to areas that are not easy to access by private investors, such as corporate bonds or emerging markets. In the next few articles, we look at what are the characteristics of funds and the different investing styles they can have.